If your New York small business is growing you may be considering whether hiring additional employees or hiring independent contractors is most cost effective.
What is the Difference Between an Independent Contractor and a Regular Employee?
The Internal Revenue Service defines Independent Contractors (IC) as individuals that provide their services to the general public. Sometimes called freelancers, IC’s retain control of how and when they accomplish certain tasks. A business owner contracts with these individuals to complete a project, but the business owner cannot dictate how the contractor completes the project.
An employee works directly for the business owner. This means that the employee must work when and where the business manager or owner directs. In addition to controlling the when and where, business owners control how the work is done.
Tax Considerations Based on Worker Classification
One significant consideration for New York small business owners is payroll related taxes. Maintaining employee-workers requires that you withhold federal and state income taxes and Medicare and Social Security (commonly known collectively as FICA) taxes from each paycheck. Business owners must maintain accurate records and forward these funds to the appropriate revenue center. Employers are also required to pay unemployment tax based on the wages earned for each employee.
Independent contractors are responsible for calculating and paying their own state and federal taxes. When hiring freelancers a New York employer need not pay any portion of the income tax, FICA tax or unemployment insurance for those subcontractors.
A word about FICA:
To help business owners and individual tax payers during the economic downturn, the IRS reduced the Social Security portion to 4.2 percent. For tax year 2013 the rates go back up to 6.2 percent. That means that business owners must contribute 7.65 percent of all gross wages earned by employees up to $113,700 per year/per individual. That percentage includes 6.2 percent for Social Security and 1.45 percent for Medicare.
After an employee reaches the base wage, employers continue to withhold and match Medicare contributions at 1.45 percent until the employee reaches a threshold of $200,000. After the threshold is met, employers are required to withhold an additional .09 percent and forward those funds to the federal government. Employers do not have to match the additional mandate.
Because mistakes with payroll and/or payroll taxes are common and very costly, it is usually better for business owners to process their payroll through their accountants or a payroll service such as Paychex or ADP.
It is important to understand that you cannot just call employees contractors. The IRS has a long list of qualifiers to determine which workers you hire as employees and which fall under the category of contractors or freelancers.
Determining eligibility involves examining the relationship between the small business and the worker. The IRS provides guidelines and explorative questions for employers to answer about workers; however, there is not a definitive set of qualifiers that clearly define who is and who is not a contractor.
As a general rule of thumb, if a business owner can answer yes to ANY of the following questions the worker is an employee.
Does the employer control what and how a worker does his or her job?
Does the business control what type of equipment is used, the pay schedule and rate and which expenses are reimbursed or disallowed?
Does the business provide medical insurance, workers compensation, retirement packages and vacation for the worker?
Is the primary work performed by the worker a necessary, continuing aspect for the business?
Business owners should always make sure that they have completed and signed W-9 tax forms for each independent contractor and LLC that they work with. This makes the Form 1099 reporting requirement much easier to deal with at year-end.
Special Circumstances for Small Business Owners
Sometimes it is necessary to ask the IRS to make the classification. We can help you file a form SS-8 with the government. This is a request for a review and formal determination of worker status. The IRS usually responds within six months to these inquiries.
If you have questions about worker classification or other accounting needs, please contact Armel Tax and Accounting Services at 646-699-4818 or firstname.lastname@example.org.